Types of Home LoansDecember 6, 2016
Possibly the most important factor potential homeowners need to consider during the home-buying process is how to pay for it. Buying a home is typically the largest purchase individuals make in their lifetime, and most people cannot afford to purchase it outright. This is where mortgages come in — but with all the different types of home loans, which one is right for you? Making the right choice can save you money, so understanding the elements of various financing programs is crucial to making the right decision for your situation. Here are two questions to ask during the home loan selection process:
Updated July 23, 2020
Fixed-Rate Loan or Adjustable-Rate Mortgage (ARM)?
The first question borrowers need to ask is whether a fixed-rate or an ARM loan is right for them.
Fixed-rate loans are the most common and offer more security in terms of predictable monthly payments. This type of mortgage is billed over a set amount of time (10, 15, 20, or 30 years) and the interest rate stays the same throughout the loan term, regardless of market fluctuation. Just as with fixed-rate student loans, you will know exactly how much you will need to pay each month. This type of loan is best for homeowners who are more risk-averse and plan to stay in the same place for a substantial amount of time.
Adjustable-Rate Mortgage (Variable)
The other option is adjustable-rate, or variable-rate, mortgages. These loans usually offer a lower starting interest rate than comparable fixed-rate loans, but the interest rates (and, in turn, payments) will fluctuate up or down at specified intervals based on current rates. ARMs come with more risk, especially in a rising interest rate environment, but the lower starting rates may offer money-saving potential provided that interest rates do not rise dramatically after the adjustment period. This loan is ideal for potential homeowners who have enough flexibility in their budgets to withstand potential payment increases or those who plan to move or refinance before the adjustment period resets.
Conventional or Government-backed Loan?
Borrowers will also need to consider whether they want (or qualify for) a government-backed loan, as opposed to a conventional loan. Any loan that is not affiliated with the government is referred to as a conventional loan. Here are some of the options the government offers for financing a home:
Federal Housing Administration (FHA) Loan
This type of loan is great for homeowners who do not have the funds available to make a traditional down payment of 20 percent, as an FHA loan allows down payments as little as 3.5 percent of the amount of the loan. However, these loans come with several conditions, such as caps of $417,000, fixed rates, and a mortgage insurance requirement.
Veterans Administration (VA) Loan
VA loans are available to qualifying veterans and offers tremendous benefits, including no money down and no mortgage insurance requirements.
United States Department of Agriculture (USDA) Loan
USDA loans are designed to help lower-income individuals in rural areas purchase a home. If you qualify, you could purchase a home with zero down payment and discounted interest rates.
Which is Right for You?
Mortgage loans are not one-size-fits-all — each prospective homeowner has a different situation with varying circumstances. For additional assistance in determining which mortgage loan program provides the ideal solution for your goals, consider consulting a reputable real estate agent or mortgage broker with experience in working with a variety of clients. Numerous programs exist to help individuals achieve the dream of homeownership, and understanding the pros and cons of each, as well as your preferences and financial situation, can help you choose a loan that best fits your needs.
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